I am very happy to be in Slovakia, a country with an exciting history, and to be in beautiful Bratislava, which I visit for the first time. My only complaint may regard your historic record of having ice hockey players that were able to score too many goals against Sweden.
I am happy to have been invited by the M. R. Stefanik Conservative Institute to speak about these important matters concerning reform. I shall say directly that my views are based on principles of free individuals, free trade and a free economy. And that is not just because these are good principles, but because free societies have created more prosperity than any other.
Of course I have studied with great interest what has taken place in Eastern and Central Europe during the last fifteen years. I remember how many people believed that great poverty, huge unemployment and dependency on foreign aid for decades would be the future of the liberated countries.
How wrong that assumption was. Of course there have been problems, and still are. But the strong increase in investments, trade and economic growth has been envied by Western Europe. The market-oriented reforms that took place had a tremendous effect. Flat tax became a topic of global discussion.
Now I know that there is a new government in Slovakia. I shall not attempt to review their program. I can just say that the reforms that Slovakia has done so far have been impressive and have produced great results. I know that many eyes are turned nowadays to the Nordic countries, perhaps also in Slovakia. And this will be my focus for today.
Most countries in Western Europe have been experiencing serious economic problems for a number of years, even if the business cycle is fairly good at the moment. Main problems include low economic growth, high unemployment and many people dependent on the government. In such times, politicians have tried to look for inspiration from other countries to solve the problems.
Most politicians know what to do. Somebody said that “We know what to do, we just don’t know how to get re-elected afterwards.” Thus, most governments try to find reforms that are comfortable in the short term. They try to find easy ways out. So instead of looking at the countries that did radical reform and succeeded, they try to find countries that seem not to have done radical reform and yet succeeded.
Why is there no radical reform? For instance, in Western Europe, many people are dependent on the state. Therefore, they will not support reforms that reduce their benefits. And those insiders who are protected by labour market regulation will not support de-regulation to create jobs for the others. There are, in this way, many obstacles to reform. That is why politicians look for shortcuts.
The Nordic countries have become the answer. They seem to be able to combine a high economic growth rate with a big welfare state, i e a successful economy with high taxes and vast systems for welfare services and social security. Many governments think they have found the way to success without uncomfortable reform.
This, however, is false on several accounts. That can of course be expected from any attempt to solve problems without actually solving the problems. I will show how it is wrong and what the proper lessons from the Nordic countries actually are.
The Nordic Model is a bit like a UFO. Everyone has heard about it, and many people think they know what it is. But few have any clue about the details of it, how it actually works – or even if it exists.
- Let me say, first of all, that there is no Nordic Model. There are great differences between the Nordic countries, placing them on opposite ends in Europe concerning many relevant aspects, such as labour market, taxes and pensions.
- Second, the Nordic countries are successful in some ways, but in very different ways. And if you want to combine these successes, you have to combine the different reasons for the success.
- Third, to the extent that they are successful, it is because of market-oriented reform away from the traditional welfare state. And where problems remain, it is because there has not been any reform.
It is of course essential to learn from the right things, what to copy and what to avoid. If you copy the heavy smoking of a mathematical genius, your mathematical skills will not improve but your health will deteriorate.
What should be avoided with the Nordic countries is big government with high taxes, regulations and welfare monopolies – they create problems. But the substantial market-oriented reforms that have been done in various fields have created success and could definitely be studied.
Before getting into the different Nordic countries, I would like to provide a brief overview of the European Social Model and its historical roots. After all, the Nordic countries are part of that, in their different ways.
There are of course differences between Western European countries, just as there are between the Nordic countries. But there are similar, basic, features too.
The tax pressure is very high and rose from about 20 % in 1950 to between 40 and 50 % in 1980 – where it stopped. Government finances and provides, one way or another, welfare services such as education, health care, child and elderly care. In various forms, the model also contains systems for social security: public pensions and income transfers for unemployment, sick leave, early retirement, etc. The labour market is also highly regulated or arranged in a corporatist way.
This model emerged largely between 1950 and 1980. It is always said that it was for the welfare of the people. But there were other mechanisms too behind:
- First, in those days, many politicians in the West believed in the centrally planned economy. A monopoly would be the best way to efficiently use resources. Thus, they put schools, health care, elderly care, pensions etc in public monopolies.
- Secondly, we have public choice. In order to win elections, politicians promised the citizen’s ever more benefits from the state. And year-by-year, election-by-election, taxes were raised and government did more. Not to mention all the special interests that want their share.
Government grew, but it had little to do with the welfare of the citizens. The core principle of the model was that there should be only one that provided welfare services and social security: the state.
It is fundamentally different from the private society. Private companies, private property, free competition, free financing, interest in profit – all these are prohibited in the public sphere.
As mentioned, there are serious economic problems following this Model. Some figures tell the whole story:
The famous aim of the Lisbon process was to close the wealth gap with the US by 2010. Since then, in 2000, the gap has widened. In fact, the average person in 38 American states is richer than the average person in any country in Europe, except in Luxemburg. And the average American is about 35 per cent richer than the European.
Employment is also higher in America. Between 1970 and 2003, employment in the US rose by 58,9 million, which is equivalent of a 75 per cent increase. In France, Germany and Italy together, it rose by 17,6 million people, or 26 per cent.
But the best comparisons can be made within Europe. Denmark has an employment rate at 76 per cent but Poland is down at 53 per cent. Youth unemployment is above 20 per cent in Greece, Italy, Sweden, France, Belgium and Finland, and between 5 and 8 per cent in Ireland, The Netherlands and Denmark.
Growth and employment has developed the best in Ireland, The Netherlands, Britain, among Western European countries, and in several countries in Eastern Europe. And without growth, no social conditions can ever improve. But the biggest problems are in the countries with the most government interventions in society; Germany, Italy, France.
The problems are not a coincidence. The centrally planned economy has never worked anywhere and can never work. We know what kinds of cars we get from a state monopoly; who thinks we get good health care from it? I usually compare the Trabant with the BMW to show the difference, but being in Bratislava I think that a comparison between the Skoda 20 years ago with the Skoda of today is just as good an example.
High taxes produce low economic growth and put a brake on job creation. Numerous economic studies show this clearly. High benefits for unemployed and people on sick leave create a disincentive to work and lead to many people living off the state. Public monopolies are as bad as monopolies always are at delivering. And regulations in the labour marker further stop job creation.
To a large extent, the Nordic countries introduced an extreme version of this very social model of a centrally planned big government. So how can it be that these countries are now often looked at with envy? Let me provide some explanation, first country by country, then with some common features and analysis.
It is not only the country with many beautiful women, Midsummer celebrations, Björn Borg and – perhaps – the world’s best ice hockey players. It is also the story of a free-market country that went socialist and then took a few steps back to free economy again. Since it is my home country, I will focus a bit on this.
Between 1890-1950, Sweden had one of the highest growth rates in the world, with an average tax burden of 10-20 per cent. This period explains much of today's wealth. Of Sweden's 50 largest companies, only one was started after 1970. It was a free-market country with a limited government that went from rags to riches.
Then, Sweden went socialist. The tax pressure more than doubled, companies were socialised, the state expanded welfare monopolies, etc. That had severe consequences. According to the OECD, the country's per capita GDP ranking slid from fourth place in 1970 to 13th place today. Inflation and unemployment went up.
In the early 1990s, though, market reforms were enacted that improved Sweden's economic performance. The telecom market was deregulated, marginal tax rates were cut, companies were allowed to provide private health care coverage, the Central Bank was made independent and the pension system was reformed.
Growth picked up in all the de-regulated sectors. Employment developed better and waiting lists to health care were shortened. But some 10-15 years have now passed since the reforms and the results are fading. Big sectors were left unreformed, mainly the labour market. And there, we have problems.
The total unemployment is independently estimated to 15-20 %. Employment grew the fourth poorest in EU-15 between 1995 and 2004. Youth unemployment is the fifth highest in EU-25 at 23 per cent. The number of early retired under the age of 30 has almost doubled since 1999 and is now over 20 000.
The recently elected centre-right government in Sweden has focused most of its promises, first budget and energy on reforming the labour market. Successful reforms there would be a logic step in the direction of successful free-market reform in Sweden.
Denmark is the country of design, windmill power stations and police thrillers. And as if that was not enough, the Danes are famous for the “flexicurity” model. They do have a successful labour market, and many sees eager to learn from its institutions. So what is the lesson?
In 1970, in terms of GDP per head, Denmark was the world's third richest country, surpassed only by the U.S. and Switzerland. In 2003 – after more than 30 years of expanding welfare state – Denmark dropped to seventh. Recent changes, such as easing firing rules, have ensured that this drop in prosperity was not more dramatic.
The Danish labour market is very successful. The lowest youth unemployment in the EU and one of the highest rates of employment overall. About a fifth of people lose their job every year, but they all find new jobs quickly.
So what is “flexicurity” except an intriguing word? A combination of flexibility and security, they say. First, a flexible labour market, with no regulations for hiring or firing. Second, high levels of benefits for the unemployed. Third, an active labour market policy to put unemployed back to work.
Which parts of that system are important? Some claim that the mix of flexibility and security, “flexicurity”, is the success model, but the pattern is clear concerning which parts are the successful ones. Countries with only flexibility still succeed while countries with only security don’t.
Then, some say that people will not allow you only to introduce flexibility. You have to give them security too. Personally, I can’t really see why a job-creating flexibility could not be accepted. But even accepting it, one does not have to accept that the government should provide the security. Private bargains and insurance could do the same and better.
The country of the Mumin Troll, a thousand lakes and Nokia. But also the country that were involuntarily closely tied to the Soviet Union, both in terms of security policy and economy, and suffered a great loss of exports when the Soviet Union collapsed. And now, Finald nis known for great economic success.
During the crisis, the government started cutting costs, accelerated privatization and eliminated the double-taxation of dividends. The public expenditure was reduced by ten percentage points between 1993 and 2003. As a result, private wealth, corporate profits and tax revenues skyrocketed.
This, in turn, made it possible to lower the personal income tax rates by six percentage points in all income groups, on average to 35 per cent from 41 per cent. Finland is open to globalisation, has done a pensions reform and build new nuclear power. These dramatic changes have galvanized the Finnish economy.
Again, it is free-market reforms that created the solutions. What was left behind was the traditional welfare state, or indeed the social model, which was more responsible for creating problems.
Norway, the beautiful land of fjords, oil and the lusekofta. It is one of Europe’s wealthiest countries in GDP per capita and has a low unemployment. To a large extent, it is a special case because of enormous oil and gas revenues. With such a special privilege, the country can be reasonably prosperous even with a big welfare state.
And yet, even there, market-oriented ideas enjoyed a certain renaissance when Norway liberalized the financial markets, abolished the state's broadcasting monopoly and introduced private hospitals. When a more “moderate” Labour party came back to power in the early 1990s it chose not to reverse these policies.
The centre-right coalition, returned to power in 2001, went further, introducing competition between private and public schools. But the current Socialist coalition won the 2005 election promising “less markets and more government”.
Geysers, volcanoes and quite a few years of real economic success, that’s Iceland. Today, this Arctic island is one of the wealthiest countries in the world. But until the late 1980s, Icelandic society was deeply socialistic with many state-owned enterprises, high taxes and excessive government interference in business. Starting in the early 1990s, Iceland has steadily liberalized.
Corporate taxes were cut to 18 per cent from 45 per cent in 1991 and income taxes to 23,75 per cent from 32,8 per cent. During the same period, most state-owned companies were privatized and streamlined regulations. Iceland's GDP grew on average 4,3 per cent annually between 1995-2005. Purchasing power has grown every year since 1995 and unemployment is 1,6 per cent.
Iceland is one of the most free-market reformist countries during the last decade. They left behind a deeply centrally controlled economy and liberalised. Despite some economic turbulence recently, they have certainly enjoyed a rapid increase in prosperity.
Thus, the conclusion that can be drawn is that the Nordic countries built their first success when they were very market-oriented with low taxes and small government. And when they tried socialism, success faded and problems mounted. Now, they have made market-oriented reforms in completely different fields of society and created success: Finland in telecom, Denmark in the labour market, Iceland in banking, Sweden in private pensions, etc.
All this is really an empirical study in the success of the market and reforms liberating free exchange. It confirms numerous scientific studies about how low taxes bring high economic growth and how a free labour market creates more jobs. Sure other countries can learn from this. Avoid the socialist big welfare state and continue to do market-oriented reforms.
The Nordic countries teach both the lesson of avoiding big government – under its various names such as welfare state or social model – and that free-market reforms work. The Nordic countries have done very different reforms, and none of them – perhaps except Iceland – has been as reformist as Ireland, Britain, Estonia, or Slovakia and have thus not had equally positive results.
In a way, you could say that the Nordic countries are greatly successful in the same way as many people in wheel-chairs are great at tennis, vastly better than I. It is not thanks to the wheel-chair; it is despite it. They still have a disadvantage, but have made efforts in other ways to compensate for it. The Nordic countries have kept big parts of the welfare state, but improved in many ways to compensate for its problems.
Last, a few words about the future. There are some trends that all European countries face to an extent, not least the Nordic countries. And the debate goes on in these countries about further reform to face the challenges. These countries will not remain as they are.
- First, we have a globalised world economy, which increases trade, investments, growth and prosperity. It increases competition and structural change in companies and jobs. And it is just the beginning. So far, only 20 per cent of the Chinese and Indians have entered the global work force. This puts great demands on us to be competitive, open, competent and, above all, embracing rapid change. Free market reforms get ever more important in this respect.
- Second, there is the demographic development. Of course it is a great achievement that we live longer. But systems designed for another kind of society will have to change. We cannot keep pensions and health care publicly funded if we don’t want taxes to explode. And we cannot keep forcing people to stop working at a certain age, but encourage people to continue working.
- Third, the content of our production is moving ever more from manufacturing to services. The ability for others to manufacture is increasing. Studies show that the more of a country’s economy that is services, the higher is GDP and the lower is unemployment. We have every reason to make this transition easy. Then, we cannot keep protecting the old jobs and structures. We must make change as easy as possible and be able to retrain people.
Any European country that wants to be really successful tomorrow will have to look at the demands of reality and of the future. Free-market reforms get ever more important. The Nordic countries have taken some steps and are likely to continue the path of reform. Thus, the one lesson from the north is to continue free-market reform and avoid big government.
Johnny Munkhammar, Director of the Program “Free Markets” at the Timbro, free market think-tank of Swedish Enterprise.
The lecture was presented at the Conservative Economic Quarterly Lecture Series (CEQLS) held by the Conservative Institute of M. R. ©tefánik in Bratislava on October 23, 2006.
The lecture is available as a video on infoNET.tv here.